By: Ryan McMaken
In our last update on money supply — using the “Austrian” measure of money supply developed by Murray Rothbard and Joseph Salerno — we found that money supply growth hit a 46-month high of 11.2 percent in October.
Growth has moderated since then, however, with year-over-year growth in US dollars dropping to 10.3 percent in November and 8.8 percent in December.
This change somewhat follows a change in M2 over the same time period as M2 growth hit a multi-year high of 7.5 percent in October, but fell to 7.3 percent and 7.0 percent in November and December, respectively.
The Rothbard-Salerno measure of money supply tends to see bigger swings than M2, and in this case the bigger swing is due partially to continued changes in US Treasury deposits at the Fed, which is not included in M2. In October and November, these deposits hit new highs unprecedented in scope, with total growth in October topping 500 percent. As described by the Atlanta Fed, “These deposits are roughly akin to the Treasury’s checking account, which is to say the amount held in the account is determined by the Department of the Treasury based on its needs.”
During the 2008-2009 period of historically large stimulus spending, Treasury deposits reached unprecedented growth levels. In late 2016, we saw some of the highest growth levels seen since 2008-2009, and this has helped to drive up money supply totals.
With the Trump administration’s focus on fiscal policy stimulus — including large increases in military and infrastructure spending (plus the proposed border wall) Treasury spending looks to increase again the near future, and this would likely contribute to ongoing increases in money totals.
What is the significance of this in relation to the business cycle?
Historically, periods of significant decline in the money supply have preceded periods of economic recession. This was the case in the period before the 1990-1991 recession, the 2001-2002 recession, and the 2008-2009 recession. with money supply growth at or above 8 percent right now, however, this does not point to a recession in the immediate future. As with any economic indicator, however, it’s impossible to guess when the current trend may substantially change.
“…Most investors now believe three things about the Federal Reserve, money and interest rates. They think that the Federal Reserve is artificially depressing rates below what would be a “normal” level. They believe that in the process of doing so the Federal Reserve has enormously increased the supply of money and they believe that the USA is on a fiat money system.
All three of those beliefs are incorrect.
One benchmark rate that he Federal Reserve has absolute control of is the rate paid on reserves deposited at the Federal Reserve. That rate is now 75 basis points, after being zero since the inception of the Federal Reserve in 1913 until recently. If the Federal Reserve had left that rate at zero t-bill rates would now be even lower than they are now. The shortest t-bills rates would now probably negative.
Paying interest on reserves combined with the subsidy to the banks of providing free unlimited deposit insurance on non-interest bearing demand deposits is keeping t-bill rates positive. Absent those policies the rate on t-bills would be actually negative. The Chinese and others all over the world are willing to pay anything for the safety of depositing funds in the USA. Already, Bank of New York Mellon Corp. has imposed a 0.13% charge on large deposits.
An investor who believes that interest rates are headed up may respond that the rate paid on reserves is a special case and that the vast increase in the money supply resulting from the quantitative easing must result in higher rates when the Federal Reserve reverses its course. The problem with that view is that the true effective money supply is still far below its 2007 level.
Money is what can be used to buy things. Historically money has first been specie (gold and silver coins), then fiat money which is paper currency and checking accounts (M1) and more recently credit money. The credit money supply is what in aggregate can be bought on credit. Two hundred years ago your ability to take your friends out to dinner depended on whether or not you had enough coins (specie) in your pocket. One hundred years ago it depended on the quantity of currency in your pocket and possibly the balance in your checking account if the restaurant would take checks.
Today it is mostly your credit card that allows you to spend. We no longer have a fiat money system. Today we have a credit money system. Just because there is still some fiat money does not negate the fact that we are on a credit money system. When we were on a basically fiat money system there was still a small amount of specie in circulation. Even today a five cent piece contains about 5 cents worth of metal, but no one would claim we are still on a specie money system.
Fiat money is easy to measure; M1 was $1.376 trillion in 2007 and is over 3 trillion now. The effective money supply is the sum of fiat money and credit money. Credit money cannot be precisely measured. However, When the person in California whose occupation was strawberry picker and who had made $14,000 in his best year was able to get a mortgage of $740,000 with no money down and private equity could buy a company like Clear Channel in a $20 billion leveraged buyout, also with essentially no money down, the credit money supply was clearly much higher than today. A reasonable ballpark estimate of the credit money supply is that it was $70 trillion in 2007 compared to $50 trillion today.
The effective money supply is the sum of the traditional fiat money aggregates plus the credit money supply. Thus, despite the claims of many to the contrary, the effective or true money supply has fallen drastically over the last few years….”
http://seekingalpha.com/article/1514632